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Supply Chain Costs: A Definitive Guide for Manufacturers

Supply chain costs

What is Supply chain costs?

Supply chain costs are defined as costs that constitute a considerable percentage of the total sales price of a product or service. Manufacturers usually define supply chain costs using the total cost of ownership. The total cost of ownership is defined as the combination of the purchase or acquisition price of a good or service. To this, they add the additional costs incurred before or after the product or service delivery. Applying the total cost of ownership analysis to the supply chain implies identifying all direct, indirect, and other associated costs.  

Supply chain costs analysis

How to calculate supply chain costs?

Most manufacturers aim at creating the most optimum supply chain for their organizations. However, at times they lack the complete information they need to reach that goal. A very common challenge they face here is the lack of visibility into all supply chain costs, and most often only focus on some of the most obvious supplier- and transportation-related expenses.

This limited view of the supply chain function’s scope fails to consider other costs that organizations absorb internally, especially with regard to purchasing products and services. Since these internal costs can significantly increase the total cost of supply, manufacturers should have the right method to identify and quantify them to avoid making purchase decisions based on inaccurate or incomplete data.  

  1. The first step in calculating total supply chain costs is to create the right context and an accurate format that can consolidate all cost factors. It is critical to identify relevant internal “issues” and translate them into their dollar values. These internal issues which could affect overall costs include physical occurrences, such as scrap rates, in-transit damage or quality improvement problems, operational issues, manual handling errors such as incorrect invoices, recurrent expediting of shipments, etc.
  2. One proven method for evaluating both internal and external issues is “unit total cost” (UTC). The unit total cost is defined as the unit purchase price amended by an appropriate monetary factor assigned to each issue. UTC helps give a clearer picture of what a specific source of supply actually costs and it is most useful when selecting or negotiating with suppliers. It also provides a context for all stakeholders to see the total picture of their organization’s costs.
  3. The next step is to map out the manufacturing process flow and identify possible issues and quantify the costs associated with those issues. These costs are divided into “hard costs” and “soft costs.” Hard costs involve an invoice or a direct cash outlay, which could include freight payments or inventory. Soft costs are those which utilize resources but have no direct cash outlay, however, they measure productivity. 

Supply chain cost drivers 

Today’s Internet of Things (IoT)- lead supply chains are quite complex and very intricately interconnected. Therefore, a cost reduction in one area of operations can directly result in a cost hike or cost variation in another. It becomes important for manufacturers to understand the interrelationship between various processes in their supply chain and the impact of cutting costs in one single area on the rest of the value chain. 

Here are some of the drivers that can impact supply chain costs in multiple ways:

1. Investment costs

Today’s global supply chains are an interconnected network of multi-site suppliers, manufacturers, distributors, and retailers that stretch across industries and geographies. Investment decisions are very critical in this scenario, to help create long term smart strategies of when, why, and how to invest in new facilities such as warehouses, factories, and the resources and equipment needed. A well-instrumented investment decision backed by effective management of investment costs can go a long way. 

Here is the manufacturers’ checklist for managing investment costs:

  • A holistic view of the entire supply chain network 
  • An intelligent market strategy and competitive knowledge 
  • Real-time insights to drive accurate data-driven manufacturing decisions for long term results 
  • Accurate predictive analysis of possible “what-if” scenarios to make sound investments.

2. Transportation costs

Usually, higher transportation costs of finished goods and services are a result of a poor supply chain planning, routing inefficiencies, and ineffective deployment of resources. Therefore, it is important for manufacturers to make the right decisions that can impact transportation costs and factors that influence it like delivery lead time, fuel price fluctuations, fleet, and cargo regulations, etc. 

Here is the manufacturers’ checklist for managing transportation costs: 

  • Appropriate design of the supply chain network for an optimal location of suppliers, manufacturers, distributors, and customers is optimal.
  • Adjusting the utilization of existing capacity by adjusting load size or engaging third-party logistics (3PL) firms when needed.
  • Planning various freight routes while taking into account the existing capacity and constraints 
  • The right selection of suppliers, distributors, co-manufacturers, transport partners, etc.

3. Procurement costs

Selecting the best supplier for your own supply chain deliverables can be a strategic decision affecting the overall supply chain costs. Those suppliers who can deliver the best material at the lowest cost and shortest time are the obvious choice.

Here is the manufacturers’ checklist for managing procurement costs:

  • Leverage your existing network of reliable suppliers and choose from known partners as they are already aware of your supply chain nuances
  • Use historical data and real-time insights to make decisions while comparing the performance and pricing of various suppliers.

4. Production costs

Production costs directly impact supply chain costs and manufacturers need to ensure they have a strategic, logical, tactical, and operational production plan in place. Simple manufacturing overhead costs including electricity, water, and equipment maintenance and repair can spike production costs to a large extent. 

 Here is the manufacturers’ checklist for managing production costs:

  • Ability to assess unit production costs based on which equipment or operational processes are inefficient. 
  • Then plan the potential manufacturing investment in new technologies after weighing in the alternatives. 
  • Tracking the effectiveness of the labor workforce including overtime, layover, TAT for finished goods, etc. 
  • Managing stretched machine set-up times and its impact on increased equipment downtime, production lead times, and reduced capacity.
  • Rework and redundant processes which lead to repurchasing expensive raw materials and even restarting the whole manufacturing process from scratch.

5. Inventory costs

Inventory is a big factor for small and large manufacturers that help them address demand and supply market volatilities and uncertainties. Ironically, while inventory is a cushion to protect manufacturers against sharp market fluctuations, it can also result in high costs. 

 Here is the manufacturers’ checklist for managing inventory costs:

  • Managing accurate inventory levels can positively impact warehousing and transportation costs which results in effective capital management to propel the company’s growth.
  • Reducing inventory costs does not equate to eliminating inventory altogether. The idea is to reduce excess inventory and to maintain just the right amount of stock of the right products. 

6. Quality costs

It is a fundamental premise of manufacturing that high-quality goods cannot be built cost-effectively from low-quality components. Quality must be a consistent aspect of doing business and should be dealt with in the same manner across the entire value chain. Especially for supply chains using just-in-time manufacturing with low inventory levels, because they cannot afford quality failures.

 Here is the manufacturers’ checklist for managing quality costs:

  • Manufacturers who adopt quality as a primary competitive strategy are better equipped to handle market fluctuations to ensure that their product costs are lower. 
  • A sound quality plan can significantly reduce rework, scrap, repeat inspection, and improve on-time deliveries. 
  • With good problem identification and problem-solving capabilities, manufacturers can benefit from superior quality, substantial savings, and fewer schedule variances.

Supply chain cost reduction strategies:

1. Asset utilization

Quick Tip -Leverage existing assets for greater productivity

  • Underutilized assets, such as vehicle fleets, facilities, or inventory create higher inefficiencies which mean poor ROI.
  • Keep a check on the way assets are used including the ownership, delivery schedules, labor utilization across shifts, adjusting warehouse capacity based on peak demand, etc.   

 2. Sales and operations planning (S&OP) 

Quick Tip-  Focus on accurate processes and then define your systems 

  • S&OP helps share information and bring people together in a structured, unified plan that spreads across the functional departments. 
  • Few signs that you might have an issue with your S&OP process include:
  1. Too many stockout incidents 
  2. High levels of “SLOB” (SLow moving OBsolete) stock
  3. Increased variations in your demand plan 
  4. Frequent alterations to the master production schedule
  5. Inaccurate or absence of proper forecasting

3. Supply chain strategy

Quick Tip – Business objectives should drive the strategy and strategy should then drive business tactics- Not the other way around 

  • Devise a supply chain strategy that drives the overall business or customer service objective, while understanding the customer’s needs.
  • Ask the below questions to validate if the strategy has been devised accurately :
  1. Have you properly documented the supply chain strategy?
  2. Is the supply chain function only restricted to one or two functional departments instead of holistically including business-wide functions? 
  3. Are certain supply chain projects being managed in silos without coordination with the rest? 

4. Inventory management-

Quick Tip- A well-planned inventory management plan can pinpoint potential cost-saving areas. 

  • Warehouse profits are directly impacted by inventory levels including incorrect stock pins, tracking errors, and over or understocking of material.
  • It is key to develop a sound inventory management strategy that includes various factors such as a procurement plan, failure analysis, and disaster management strategy. 

5. Transportation strategy

Quick Tip- A well-defined transportation strategy can open several hidden areas of supply chain cost savings  

  • A transportation strategy that includes key factors from a supply chain perspective can lead to reduced costs from crowdsourced P2P transportation services to in-house product movement via drones or even on-demand shipping container services.
  • It can also avoid risks in fleet management and predict equipment breakdown, eventually saving millions of dollars in repairs and reactive accident management activities. 

Role of Artificial Intelligence in reducing supply chain costs 

For manufacturers, the supply chain is the life-line of their business that works with physical products and therefore it requires a lot of man-hours and resources to operate effectively. The two main benefits of AI-enabled supply chain and adoption in the smart supply chain management are increased operational efficiencies and reduced supply chain costs. 

According to a study by McKinsey, supply chain savings are an outcome of better spend analytics and better network optimization. For manufacturers, supply chain cost savings are a result of improving “yield, energy, and throughput”.

The positive impact of AI in supply chain costs includes enhanced shipping efficiencies, identifying patterns and plans for predicted customer behavior, more accurate data for supply chain forecasting, faster decision making, and creating stronger and high supply chain efficiency designs.  

One important area where AI shows significant supply chain promise is the process of eliminating wasteful bottlenecks which can help reduce operational costs. ThroughPut’s Supply Chain Management Software ELI, is an AI-Powered Bottleneck Elimination Engine that helps substantially bring down supply chain costs. ELI continuously detects, identifies, prescribes & prevents shifting bottleneck operations to save millions in delays, inefficiencies & lost revenue. 

Your customers finally get their orders processed faster and you save money by focusing on automated, sustainable, and efficient supply chain operations. All of this while using your existing data in real-time. 

If you wish to start experiencing significant cost savings across your supply chain, you should try ELI for free today. 

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